Does Implementation Guidance Affect Opportunistic Reporting and Value Relevance of Earnings?

Abstract

In recent years, both the SEC (2003) and the FASB (2004) have indicated a need for accounting standards where principles are balanced by implementation guidance (i.e., a framework for exercising professional judgment). In this study, we take advantage of a jurisdictional split during 1996-2001 whereby the same economic event (i.e., an impairment in oil and gas assets) in the extractive petroleum industry was accounted for by full cost firms under a SEC standard (Regulation SX 4-10) which provides extensive implementation guidance, and by successful efforts firms under a FASB standard (SFAS No. 121) that provided relatively little guidance for implementing the standard.

We utilize this jurisdictional split (which provides a natural quasi-experiment) to evaluate whether the differential guidance for recognizing impairment losses provided by Reg. SX (for full cost firms) and SFAS No. 121 (for successful efforts firms) is associated with differences in opportunistic reporting (as proxied by an association between the reported write-downs and managerial incentives to report opportunistically) and differences in the value relevance of the write-downs (as proxied by their association with stock returns). Our findings are inconclusive as to whether implementation guidance limits opportunistic reporting, but are broadly consistent with the notion that such guidance potentially undermines the value relevance of accounting information. Collectively, our findings provide accounting policy makers with an additional piece of evidence with which to evaluate the role of implementation guidance in standard setting.

Keywords: Rules vs. Principles, Implementation Guidance, Opportunistic Reporting, Value Relevance, Impairment Loss (write-down)

JEL Classification: G38, M41, M44, G12